Tariffs And Quotas

Question 1:

Tariffs and quotas:

Tariffs and quotas are trade restrictions imposed on imports and exports, they are imposed on goods in order to protect domestic industry, earn government revenue or restrict the quantity of imports. A tariff is a form of tax that is revised on imports or exports, when a tariff is imposed on a good the price of that product increases, the following diagram demonstrates the effect of tax on consumer and producer surplus. A quota on the other hand is a quantitative restriction on goods. A quota involves stating the maximum amount of a good that can be imported from a certain country. (Hardwick, 2002)

The difference between a quota and a tariff is that the government will earn revenue while a quota does not. A tariff leads to deadweight loss whereas for a quota the loss in producer and consumer surplus benefits quota holders. A tariff is preferred given that it earns government revenue whereas quota does not yield any revenue. (Hardwick, 2002)

Comparing a quota, tariff and free trade a country should consider free trade, a tariff is preferred over a quota but through free trade a country can gain more through trade, according to Adam smith and David Ricardo a country will gain from trade due to absolute and comparative advantage, therefore a country should not restrict trade by imposing tariffs and quotas. (Hardwick, 2002)

Tariffs And Quotas

Question 2:


Negative externality:

Externalities are defined as costs or benefits that are incurred yet they are not paid for, a negative externality occurs when firms fail to account for all the costs incurred, for example a firm’s production process that degrades the environment through air pollution, the firm only accounts raw material and labor costs disregarding the environmental costs incurred. (O’Hara, 2008)

Positive externality:

A positive externality is a benefit accrual to a firm or individual whereby the price of a product does not reflect the full benefit of the product, a good example is a public good for example roads, some individuals may not pay taxes and yet utilize the roads and therefore this is a positive externality. (O’Hara, 2008)

Coasean solution:

The Coasean theory gave a solution to externalities, this theorem was developed by Ronald Coase in 1957, the argument is this theory is that given that there are number of radio stations in the market, radio stations may decide to broadcast on the same frequency and therefore

Tariffs And Quotas

interfere with their competitors broadcast, one radio stations that has higher economic gains in terms of profits from broadcasting may decide to eliminate the problem of interference(negative externality) by paying off its competitors. For this reason therefore if the market is perfectly competitive parties that face negative externalities caused by rivals will still eliminate externalities through negotiations. (McConnell, 1997)

In the above case the mentioned negative externality is air pollution in the production process of a firm, this problem can be resolved through negotiations whereby the firm may negotiate with individuals in the market and come to an agreement to resolve this problem, a good example is the current negotiations between countries to reduce carbon dioxide emissions. (McConnell, 1997)

Question 3:

The Coasean theory is based on the assumption that there are no transaction cost involved, this means that there are no barriers to bargaining and therefore bargaining will occur, however if bargaining costs are high then the Coasean solution will not occur, this assumption that transaction costs are zero is unrealistic given that in most cases there are high transaction costs involved in the bargaining process. (McConnell, 1997)


Campbell McConnell (1997) Economics: principles, problems, and policies, New  York:

McGraw hill press

Tariffs And Quotas

Frank O’Hara (2008) Introduction to Economics, New York: John Wiley and sons publishers

Hardwick, P. (2002) Introduction to modern economics, New  Jersey: Prentice hall publishers